The 2016 general election represents one of the biggest upsets for the office of US president in the 240-year history of the United States.
Although unexpected and stunning the world, the election of Donald Trump shouldn’t have been a big surprise. Despite polls (which were within the 3 percent margin of error) forecasting a Clinton administration as recent as the day before the election, Trump nevertheless prevailed.
His election represents a significant departure from the establishment as the first president-elect without any experience in either government or the military. Populist views permeated through his campaign message—securing US borders, imposing tariffs, and preventing US-based jobs from being outsourced. Populism has been spreading across the globe (as seen with the BREXIT vote earlier this year), and the outcome of the US presidential election confirms it’s gripped a significant number of Americans as well.
Although Trump is clear on the issues he intends to affect, details of his plan are vague. This lack of specificity and his dearth of experience in government poses a great deal of uncertainty in the near term, perhaps unmatched after any past presidential election in American history.
Trump made several campaign promises that inspire many more questions. He promised to repeal the Affordable Care Act, but what will replace it? Will a wall be built along the United States-Mexico border? How will it affect relations between the two nations? What trade tariffs can we expect and on which countries? Will the North American Free Trade Agreement, known as NAFTA, be abolished?
Many of us, on both sides of the aisle, are wondering how these issues will develop and which he’ll pursue first. If his campaign promises remain intact as they pass through Congress and become policy, how will they affect the nation’s future, specifically the economy and markets? From an economic and market perspective, we can only speculate what the impacts will be. However, anticipating what could transpire provides a baseline from which to pivot as events unfold.
Potential Economic Impacts
Trump’s tax plan focuses on reducing individual and corporate taxes. He wants to reduce the number of individual tax brackets from seven to three by removing the upper brackets. He also proposes getting rid of the estate tax and capping deductions. The bump in discretionary income for individuals could provide a short-term growth to the US economy. However, it could be argued that increasing income for individuals doesn’t have the same multiplier effect on the economy as incentivizing businesses to increase capital expenditures does.
Trump’s tax plan also includes reducing the corporate tax rate to 15 percent. The US corporate tax rate is currently among the highest in the world, and this change would be economically beneficial in the long term. Another plan is to provide a tax holiday to multinationals in order to repatriate cash held within foreign entities. This is likely to have a small economic benefit in the short term, as corporate America is already flush with cash.
Spending and Debt
Infrastructure spending would also be additive to economic growth; however, without the proper transmission mechanism to direct funds to projects with lasting economic value (repairing roads and bridges), there’s a possibility the funds are utilized in a similar manner to the last infrastructure package (repainting schools), which would result in a short-lived increase to gross domestic product. With increased infrastructure spending coupled with reduced taxes, it’s estimated that federal revenue will be reduced by $6.2 trillion over the next decade.
The Department of the Treasury will need to increase bond issuance to finance those deficits, which would cause the national debt burden to increase from its already bloated levels. Since the election, Treasury bond yields rose to their highest levels this year, in anticipation of this increased supply.
Inflation’s the enemy of bonds as it erodes the value of the fixed coupon payment of a bond. Inflation basis points already went up 11 points the day after the election, more than 50 percent more than it rose the previous two months. This is probably a result of the increased debt load now expected in addition to increased tariffs. Even though inflation expectations have increased, it’s difficult to see inflation sustaining itself above 3 percent over the next 12 months.
During the campaign, Trump vowed to renegotiate current trade deals. He specified a 35 percent tariff on imported goods from companies that outsource American jobs to Mexico and a 45 percent trade tariff on imports from China. Annually we import almost $300 billion from Mexico and nearly $500 billion from China, which account for 35 percent of total US nonpetroleum goods imported. The combination of these two tariffs is estimated to increase import prices for Americans approximately 15 percent and lift overall US consumer prices to 3 percent within six quarters after import prices increase. This could end up cancelling out any increased income from reduced individual taxes.
Potential Capital Market Impacts
Stock market futures were down significantly during the overnight session after the outcome of the election became apparent, only to recover dramatically when trading opened the morning of November 9. The overnight volatility experienced may be a precursor to increasing volatility among stock markets in the coming months as the public receives greater clarity on the president-elect’s intentions. As investors digest the potential consequences of a Trump presidency, we suspect the stock market will gradually trend higher based on existing market and economic conditions. Third quarter earnings were good, and the economy isn’t flashing signals that a recession’s imminent.
Despite the recent rise in interest rates, they still aren’t high enough to compel investors to buy bonds versus stocks. Inflation expectations have clearly increased, but at this point in time it’s difficult to see inflation sustain itself above 3 percent over the next 12 months. Also, keeping the rise among interest rates at the margin is the persistent, demographic trend of aging populations among countries where global wealth is concentrated—another factor that should prevent interest rates from rising substantially.
The result of the presidential election creates political uncertainty, but should have little near-term impact on the capital markets. The underlying fundamentals haven’t been altered from their current course, and fiscal policy changes in particular will take time to implement and even more time to have an effect on the economy.
Things remain fluid, but at this time we haven’t dramatically changed our outlook for the next 12 months. The Federal Reserve will remain focused on economic conditions, and we don’t see the new administration influencing a change in their program. The election results have been dramatic and surprising, but once again, the only constant remains change. We will adjust as conditions dictate, but even as information and policies continue to change, we recommend staying the course.
We're Here to Help
To learn more about areas of opportunity for your portfolio, or for more information on how these events and others might impact it, contact your Moss Adams wealth advisor.